Reinhart on China: Banking System A Risk, Float Yuan

Project Syndicate: China’s Incompatible Goals
Those looking for a rough outline of the Chinese economy’s future would be wise to revisit what happened in Thailand in 1997, when the collapse of the baht precipitated the Asian financial crisis. Of course, China in 2016 is different in many ways from Thailand in 1997; but there are key similarities in their responses to ongoing capital outflows.

...History shows that when an economy starts to sputter, central banks find it extremely difficult to resist domestic calls for action. This is especially true when the emergence of systemic banking problems calls for support from a lender of last resort. In our academic work, Graciela Kaminsky of George Washington University and I have shown how, as financial markets have been liberalized and become globally integrated, banking-sector problems have regularly set the stage for currency crashes.

...Since 2008, however, much of the Chinese policy stimulus in response to the global financial crisis has taken the form of a markedly expansionary monetary and credit policy. As a result, money growth outpaced reserve accumulation during the 2008-2014 period.
...China may find it advisable to allow the renminbi to float sometime soon, rather than waiting until a full-fledged confidence crisis forces its hand.
Chinese steel mills were clearly headed for trouble back in 2011 and 2012, and in 2013, the Beijing Times ran story on collapsing steel margins. Now it is 2016 and bad debts are finally being exposed, and hopefully resolved. Can China continue this pace of dealing with economic problems or will reserves run out first?

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